The South Korean government's efforts to use a primary collateralized bond obligation program to help ease the credit crunch that is afflicting the country's second-tier businesses (ASRI 7/3/2000 p.1) are already bearing fruit.

The first deal, which is being arranged by LG Investment & Securities, has already raised W1.55 trillion ($1.38 billion) for 54 medium-sized firms.

LG purchased two-year corporate debt issued by the firms at the market rate and then parceled the bonds into a four-tranche CBO. The underlying bonds were rated between triple-B and double-B, but the senior tranches of the CBO are expected to be rated at triple-A and double-A thanks to the diversification and a partial guarantee of 24% of the issuance from two local monolines.

The guarantees come from one state entity, the Korea Credit Guarantee Fund, and one semi-state entity, Seoul Guarantee Insurance Co.

The senior tranches make up 90% of the deal, with the remainder coming from two subordinated pieces, plus a first-loss equity piece worth 3% of the total.

Companies that have issued the two-year paper that is backing the CBO include Asiana Airlines, Dong Suh Industrial, Kumho Petrochemical and Youngpoong. The companies have issued bonds worth between W20 billion and W44 billion.

The transaction had not closed by presstime, so pricing or distribution details were not available.

According to Chang Ho Moon, a senior analyst with rating agency Korea Investors Service (a joint venture with Moody's Investors Service), his agency and the other local agencies that will rate the deal have imposed strict concentration limits on the underlying pool; for example, restricting the concentration of paper issued by each chaebol group to no more than 10%.

LG's deal is expected to be followed with a similar transaction this week from Hyundai Securities, which is targeting a figure of between W450 billion and W500 billion.

"With some W2 trillion to be raised this month alone, the primary CBOs are expected to help alleviate the liquidity squeeze at mid-sized businesses," Ryu Heung-soo, the director of the financial watchdog body, the Financial Supervisory Service, told the Korea Herald.

The deals are the first moves in the government's primary CBO program that is expected to mobilize up to W10 trillion for medium-sized businesses in an effort to deal with the liquidity crunch that is affecting lower-rated companies.

The program, which has been organized by the government and the FSS, has won commitments from the financial sector to raise W10 trillion to invest in the Korean bond markets, with half of that figure dedicated to buying CBOs and the remainder to buying straight corporate paper. The initial two deals will be followed be a series of several more over the next few months.

The program is part of the Korean authorities attempts to protect businesses from the credit crunch that has effectively closed the straight bond market to companies rated below single-A. Investors, increasingly nervous after the bankruptcy of the Saehan Group and the cashflow problems at Hyundai and Ssangyong groups, have refused to allow many smaller companies to roll over their liabilities, leaving those businesses dangerously exposed.

Such companies have also been unable to turn to bank lending, as the country's banks, burdened with non-performing loans, are focussing on improving their capital adequacy ratios, rather than advancing funds to second-tier businesses.

Experts in Seoul also pointed to another reason why the Korean government is keen on a primary CBO program: it will allow the authorities to make the most efficient use of the remaining resources of the two monoline guarantors.

Both companies have racked up losses from guaranteeing corporate bonds, which they have to stand behind 100%. With a CBO, however, the companies can issue a partial guarantee (in this case 24%) to act as credit enhancement - meaning that 27% of this deal (including the 3% equity piece) would have to turn sour before investors are affected. "They will leverage every single dollar by five by turning to the CBO structure," Moon said.

Whether the plan will work in the long term, however, is a subject of debate. "Some people, including the government, think that the liquidity problems are temporary and due to some misconception in the capital markets about the credit quality of corporations," said one ABS specialist in Seoul. "But most people think that the distortion of the capital market is due to systemic problems, reflecting more fundamental difficulties, and that corporate restructuring is the only way to address it.

If the government's view is correct, the specialist continued, then the program may save those companies faced with an inability to raise funds. But if the pessimists are right, then it will temporarily mask the problems, only to see them return in the not too distant future.

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